US Credit Update – Signs of Stability
Highlights from U.S. Credit Markets:
- Investment grade corporates lagging
- Financials lead new issuance
- Financials’ outperformance moderates as Treasuries recover
- Utilities poised to outperform if Treasury yields fall
- Energy still leading among industrials
Investment grade corporates lagging
High yield bonds outperformance and investment grade bonds lagged last week as most of the U.S. credit market found some stability. Results overall were modest for the week with most seeing marginal positive returns for the week. Only leveraged loans have seen positive returns over the past month.
Our corporate desk had the following comments on Friday:
Volume in credit markets was below average this week and volatility continued to decline. The VIX closed down 2.7% and stocks were mixed. New issuance picked up slightly, but most of the deals were smaller in size. The IG CDX index closed the week +4 basis points, while HY went out -$0.5. As the week came to a close, it felt like the street was long plenty of inventory and willing to provide a limited bid side. Domestic financial spreads backed up 2-5 basis points, but the Yankee bank sector was softer by 5-10. Cyclical sectors and those who have seen tremendous movement over the past few months, like energy, remain well offered.
Financials lead new issuance
The financial sector was back on top of the primary market leaderboard. BNP Paribas and American Express brought the only two deals totaling more than $2 billion, for $2,750 and $2,000 respectively. Only one other deal topped $1.5 billion as the lingering nerves kept issuers on the sidelines.
Financials’ outperformance moderates as Treasuries recover
Last week we briefly discussed the relationship between Treasury performance and the relative performance with U.S. investment-grade credits. The charts below show 22-day changes in the Bloomberg Barclays U.S. Treasury index (x-axis) and the difference between 22-day total returns for the Bloomberg Barclays financials index and the utilities (left) and industrials (right) indices. Rising Treasury yields favor financials outperformance against both peers, but the relationship is much cleaner for utilities. Some, but not all, of this can be explained by financials carrying lower duration, on average.
Last week the U.S. Treasury index total return fell to -1.4% and financials outperformance may have reached an extreme. Our outlook for Treasuries favors falling yields over the next month, especially for the short end of the treasury curve. These charts suggest that, if Treasuries sustain a rebound, utilities are a better bet to outperform financials that industrials.
Utilities poised to outperform if Treasury yields fall
This next chart shows this would be a return to the prevailing state of affairs from the second half of 2017. The Bloomberg Barclays utility index outperformed financials through the last six months of the year, peaking December 15 with utilities at +7.9% versus Treasuries at +5.7%. Many are wondering if rising yields have run their course in the wake of the inflation and budget deficit scares. Reverting to the conditions before those two shocks would favor utilities.
Total returns for the utility index have suffered this year with much of the index seeing returns of -3% or worse. Integrated electric is the largest industry group within the index and sits at -2.9% for 2018. The chart on the right below shows average 2018 total returns by average duration. Among the longest duration issues, water utilities (-3.0%) have outperformed electrical transmission issuers (-3.5%).
Energy still leading among industrials
With industrial total returns essentially flat on the week, little has changed in the following chart. Energy remains one of the top performers, especially against industry groups with similar average durations.
Energy still leading among industrials
Rising crude oil prices have been a tailwind for the industries most sensitive to spot prices, exploration and production and field services. Pipelines have been another bright spot with surging shale production stretching the limits of existing pipeline capacity.
The next chart shows the best and worst performing pipeline issuers last week on a spread basis. Transcontinental saw spreads tighten over 4 bps on average. Kinder Morgan is still plagued by regulatory and political delays in Canada and saw spreads wider by over 4 bps across multiple divisions.